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S. HRG. 108–6

TAX FAIRNESS:

DOES DOUBLE TAXATION UNFAIRLY TARGET

OLDER AMERICANS?

HEARING

BEFORE THE

SPECIAL COMMITTEE ON AGING

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

WASHINGTON, DC

FEBRUARY 4, 2002

Serial No. 108–2

Printed for the use of the Special Committee on Aging

(

SPECIAL COMMITTEE ON AGING

LARRY CRAIG, Idaho, Chairman

CONRAD BURNS, Montana

RICHARD SHELBY, Alabama

RICK SANTORUM, Pennsylvania

SUSAN COLLINS, Maine

MIKE ENZI, Wyoming

GORDON SMITH, Oregon

JAMES M. TALENT, Missouri

PETER G. FITZGERALD, Illinois

ORRIN G. HATCH, Utah

Elizabeth Dole, North Carolina

TED STEVENS, Pennsylvania

JOHN B. BREAUX, Louisiana, Ranking

Member

HARRY REID, Nevada

HERB KOHL, Wisconsin

JAMES M. JEFFORDS, Vermont

RUSSELL D. FEINGOLD, Wisconsin

RON WYDEN, Oregon

BLANCHE L. LINCOLN, Arkansas

EVAN BAYH, Indiana

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

LUPE WISSEL, Ranking Member Staff Director

MICHELLE EASTON, Staff Director

(II)

C O N T E N T S

Page

Opening Statement of Senator Larry E. Craig ..................................................... 1

Statement of Senator John Breaux ........................................................................ 3

Statement of Senator Orrin Hatch ......................................................................... 4

Statement of Senator Gordon Smith ...................................................................... 27

Statement of Senator Thomas Carper ................................................................... 50

Statement of Senator James Talent ....................................................................... 83

PANEL I

Hon. Glenn Hubbard, Chairman, President’s Council of Economic Advisors,

Washington, DC ................................................................................................... 6

Hilary J. Kramer, Senior Strategist and Advisor, Montgomery Asset Management, and Business Commentator, Fox News Channel, New York, NY ......... 30

PANEL II

Dick Buxton, Boise, ID ............................................................................................ 55

Dan Mitchell, McKenna Senior Fellow in Political Economy, The Heritage

Foundation, Washington, DC .............................................................................. 60

W. Mark Crain, Director, Center for Study of Public Choice, and Professor

of Economics, George Mason University, Fairfax, VA ...................................... 70

(III)

(1)

TAX FAIRNESS: DOES DOUBLE TAXATION

UNFAIRLY TARGET OLDER AMERICANS?

TUESDAY, FEBRUARY 4, 2003

U.S. SENATE,

SPECIAL COMMITTEE ON AGING,

Washington, DC.

The committee convened, pursuant to notice, at 10:05 a.m., in

room SD–628, Dirksen Senate Office Building, Hon. Larry Craig

(chairman of the committee) presiding.

Present: Senators Craig, Smith, Hatch, Talent, Breaux, and Carper.

OPENING STATEMENT OF SENATOR LARRY E. CRAIG,

CHAIRMAN

The CHAIRMAN. If the room would come to order, let me convene

this U.S. Senate Special Committee on Aging. Before we start the

hearing this morning, this is a difficult day in our country and I

would ask that you join me in a moment of silence.

[A moment of silence was observed.]

I thank you very much for that. It is a difficult morning in America, but those seven who lost their lives on Saturday that we honor

and recognize today at the Johnson Space Center in Houston would

be the first to tell us it is important to get on with life and for this

country to continue to function so well and to be able to properly

deal with the problems that it faces, and that is, in part, what this

hearing is about today.

I have been joined with my colleague, Senator Breaux, who has

chaired this committee for the last nearly 2 years and we have

worked very cooperatively on a variety of issues. This is one, as I

began to delve into it, that I found absolutely fascinating and appropriate for this committee to deal with. Why? Because I really do

believe it speaks to the issue of double taxation, and after I have

looked at this, the method by which double taxation unfairly targets older Americans.

We are pleased to have some of the nation’s top economic experts

testifying on what impact double taxation has on our senior citizens, with a particular eye on the President’s tax relief plan. I look

forward to their testimony.

When you study the tax code, it becomes apparently clear that

older Americans, both working and retired, are subject to double

taxation more than most other age groups. The question we hope

to explore today is whether the rhetoric about tax cuts for the rich

is really about tax relief and fairness for our seniors.

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Older Americans are more likely to hold investments in assets

that pay dividends than other age groups. Millions of seniors, many

on fixed incomes, rely on dividend income to make ends meet from

month to month. The pie chart to my right, your left, shows that

52 percent of seniors receive taxable income.

Ironically, my wife is en route back from Tucson this morning,

where she has spent the last 4 days with her 85-year-old mother,

who is now a widow living in a retirement community in Tucson.

She was a nurse all of her life. Her husband, my late father-in-law,

was a career military person. They were not wealthy, but they

were frugal and they cautiously and quietly invested all of their

lives for their retirement. I asked my wife this morning, when she

had taken all of the materials with her mother over to the tax accountant these past few days, about how much of Shirley’s income

is going to be dividends. My wife said, ‘‘Over 50 percent.’’ It is interesting that that work is being done now as we get

ready to visit our accountant and pay our taxes, that the pie chart

and the studies really are reflective of a good many seniors across

this country, and I will tell you that my mother-in-law, like many

in our country, does not classify as a wealthy person. But most assuredly, she receives a large share of her income from the very

issue we talk about today.

The Cato Institute recently published data from the Organization

for Economic Cooperation and Development showing dividends and

corporate tax rates around the world. The bar chart to my right,

your left, is a summary of the Organization for Economic Cooperation and Development data. The U.S. has the second-highest combined Federal, State, and local dividend tax rate in the world. The

chart begs the question, why would any company pay a dividend

under these stifling tax rates? We hope to hear from our witnesses

on this question.

I also find it ironic that we are second from the top and the top

is Japan, and Japan for the last decade has struggled to try to get

its economy going and get investment back into it.

Older Americans are also subject to double taxation by the Federal Government in the form of the death tax and the taxation of

Social Security benefits. The death tax has forced the break-up of

family farms and the sell-off of small businesses in order to pay the

government after death. It is unfair to tax a person’s savings and

earnings twice while they are alive, but it is immoral to tax those

life savings again, in my opinion, when a person dies.

Today’s seniors already pay income taxes on their payroll taxes

when they work, and now a growing number of modest and middleincome seniors must pay income taxes again on already taxed Social Security benefits. For many seniors, 85 percent of their Social

Security benefits are taxed. This tax is a disincentive for seniors

who want to work.

I am looking forward to the testimony from the Chairman of the

President’s Council on Economic Advisors who is with us, Glenn

Hubbard, and also Hilary Kramer of Montgomery Asset Management, a regular business expert appearing on Fox News, as our

first panel.

Our second panel will be Dick Buxton, one of my constituents,

who will describe the impact of double taxation on his family in

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Idaho. Also testifying are Dr. Dan Mitchell, a tax reform expert

from the Heritage Foundation, and Dr. Mark Crain, a Professor of

Economics at George Mason University and a Trustee for the Virginia Retirement System.

We look forward to hearing more about these issues from our

panels of witnesses, and so I welcome them.

But before I turn to the panels, let me turn to my colleague John

Breaux from Louisiana, who has been an outspoken and appropriate leader for the senior community for a good number of years.

STATEMENT OF SENATOR JOHN BREAUX

Senator BREAUX. Thank you, Mr. Chairman. I will try to be very

brief. I think it is appropriate that we look at tax recommendations

on a regular basis, particularly to determine whether the tax code

targets any group of Americans unfairly or differently from others,

and I think that the purpose of the hearing this morning is to look

to see if there are problems in the existing code which unfairly

treat seniors.

The fact is, on Social Security taxes, the benefits of most recipients are not taxed. Most seniors who are retired do not pay taxes

on their Social Security income because you don’t start paying it

until you reach a certain threshold. The 85 percent taxation coverage only kicks in when seniors have a single income in retirement of over $34,000, or $44,000 for a couple. The average income

in Louisiana for working people is about $22,000 a year. That is

for working people, so for retired people, it is much less than that.

So most of the benefits of people who get Social Security are not

taxed. Some are. The concept is that there should be taxation of

those benefits that exceed the contribution of an individual that

they have placed in over their working years. Congress has determined back, I guess, in 1993, that that was an appropriate request

for seniors who reach a certain income level in requirement to help

shore up the Social Security system, which, if you have seen the

projections on the difficult situation that it is in, as well as the

Medicare program under the HI portion of the Social Security tax.

So it is appropriate that we can look at this, but we also need to

keep it in proper perspective.

The second portion is the double taxation of dividends. I think

as a policy measure, double taxation is not a good idea. Having

said that, over half of the President’s tax proposal is addressing

this problem, which originally was a proposal to stimulate the

economy. Almost every economist that we have talked to has indicated both publicly and privately that elimination of the double

taxation on dividends is not going to be short-term stimulative to

the economy. Is it correct policy in the long term? The answer is

probably yes and I think we need to take a look at it in that vein.

But at the same time, I would point out that in my State, which

a lot of other States fall in the same category, only 8 percent of the

people in my State of Louisiana are subject to any tax on dividends

at all, 8 percent, IRS figures. So we are going to spend $374 billion

on a program that 92 percent of the people in Louisiana don’t pay

taxes on anyway. Now, is that good tax policy? Maybe. Is it worth

over half of the total package? I question it. Does it stimulate the

economy? The answer is no.

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So these are all questions that are appropriately being discussed

here today and we need to hear both sides of the issue and I

thought that is why I would say what I said. Thank you.

The CHAIRMAN. John, I appreciate those comments and your

frankness and the openness. That is the value of this committee

and the purpose of hearings, to build an objective record on this

important issue.

We have now been joined by my colleague, the senior Senator

from the State of Utah, Orrin Hatch. Orrin?

STATEMENT OF SENATOR ORRIN G. HATCH

Senator HATCH. Thank you, Mr. Chairman. I want to welcome

both of you here. We appreciate both of you being here. Dr. Hubbard, I have watched your career down at the White House and I

think you are doing a terrific job. I think as one of the designers

of the President’s tax program, you have made some bold moves

here that I think could make a real difference in our society.

I am appreciative, Mr. Chairman, of you scheduling this hearing

today. I am new to this committee and I look forward to working

with you and Senator Breaux on the issues that matter to Utah’s

seniors and seniors all over the country.

I am especially glad we are here today discussing the double taxation of senior citizens. Millions of older Americans pay far too

much in taxes, and this year, we are going to cut those taxes. Our

nation’s seniors spent decades working long hours, scrimping and

saving for their well-deserved retirement, only to find that no matter how old they get, the tax man still has seniors in his sights.

Age springs wisdom, but not tax relief, and this year, I want to

help the President change that.

President Bush wants to cut income taxes for seniors. He wants

to lower their marriage penalties, and he wants to eliminate the

double tax on their dividends. I think this is the right plan for

America’s seniors as well as everybody else.

This hearing examines the double tax on dividends. Over half of

all income tax filers over 65 years of age pay tax on dividends, and

over one-third of all filers between age 55 and age 64 have taxable

dividends. Millions of people saving for retirement, close to retirement, or working for an early retirement are also paying these double taxes. Right now, corporations give more than a third of their

profits over to the government in taxes, and then we demand that

when investors get their share of these profits in the form of dividends, they have to pay income tax on it again. As President Bush

keeps reminding us, taxing income once is fair, but taxing it twice

is not fair.

Mr. Chairman, this is not a question of rich versus poor. Elderly

Americans with modest incomes receive substantial stock dividends. In fact, more than half of all tax filers over the age of 65

earning between $30,000 and $40,000 per year receive taxable dividend income. Because our nation’s senior citizens have been so

thrifty during their lives, these dividend payments are sizable. Seniors who receive dividends and earn between $30,000 and $40,000

per year in total income receive an average of over $2,000 per year

of that income as taxable dividends.

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Further, ending the double tax on dividends will decrease the

risk of bankruptcy and improve corporate accountability. Over my

years of public service, I have met far too many seniors who have

lost part or all of their savings because the companies that they invested in went bankrupt. Last year, we enacted tough corporate accountability reforms to help strengthen our nation’s capital markets. This year, we should enact the President’s corporate reform

tax cut to finish the job. America’s seniors will be rewarded with

safer investments and a more secure retirement.

I am very interested in this issue, but unfortunately, my duties

are not going to permit me to stay at all here because I have got

to be over in the Capitol in just a few minutes, but let me just say

one thing. I have got an analysis that says this more than $300 billion revenue loss from the dividend plan would be more than made

up over the years and that if you use any kind of scoring total besides static analysis, the country would wind up actually benefiting, not only because we wouldn’t be paying double taxation, but

because, in essence, Treasury would get as much revenue anyway.

I remember when we were arguing for capital gains rate reductions on the Hatch-Lieberman bill in 1997. The argument against

it was, using a static analysis, that we were going to lose revenues.

Our argument was, the Treasury wouldn’t lose revenues and we

would probably gain revenue. Well, a study by DRI, not a conservative econometric modeling firm, concluded that, yes, we didn’t lose

revenues, that we slightly gained on the capital gains rate reduction.

I suspect removing the double taxation of dividends is going to

have a similar effect over time. So I would be interested in knowing

what you feel about that, both you, Ms. Kramer, and you, Dr. Hubbard, because I think sometimes people around here using static

analysis are wrong. In fact, many times, they are wrong. Now, I

think we could go too far in using a dynamic analysis, too, but

there ought to be something in between that acknowledges that

there is some dynamism in the economy that will work in favor of

tax rate reductions.

I just want to compliment both of you, but especially you, Dr.

Hubbard, for the work you are doing down there at the White

House. It isn’t easy to make these type of decisions. It isn’t easy

to promulgate them. It is certainly not easy to win on them, but

I intend to see that you win this year and I just hope that we can.

Thanks, Mr. Chairman. If you will forgive me, I had better get

over there.

The CHAIRMAN. Orrin, thank you very much, and in the course

of their testimony, it is possible that Mr. Hubbard could respond

to your query. But I do thank you for coming this morning.

Now let us turn to our first panel. I had mentioned in my opening comments their introduction. Dr. Glenn Hubbard is Chairman

of the President’s Council of Economic Advisors, and as I think

Senator Hatch has said, ‘‘He has worked with the President to put

forth a daring tax reform stimulus package that is now before the

Congress and will clearly be before us soon.’’

Again, this morning, we want to focus on the impact on the senior community, a community of fixed-income Americans who vie

6

with inflation and a variety of costs in which they and we all live,

but unlike us, in many instances, their incomes are fixed.

Second on the panel is Hilary Kramer, a Senior Advisor and

Strategist at Montgomery Assets Management and Business Commentator for Fox News Channel.

We welcome you both. Dr. Hubbard, please proceed.

STATEMENT OF HON. GLENN HUBBARD, CHAIRMAN, PRESIDENT’S COUNCIL OF ECONOMIC ADVISORS, WASHINGTON,

DC

Dr. HUBBARD. Thank you very much, Mr. Chairman, for holding

this hearing, and thank you, Senator Breaux. I think this is an extremely important topic that you have raised, Senator, and the implication for seniors.

What I want to do in my oral remarks is really just focus on a

couple of things with you. One, to go over the questions you asked

directly about seniors in your remarks, but also to tell a little story

of why I think this is economic policy that the Aging Committee

should be concerned with going long-term, as well, and to get at

the issue of why, if you never receive a dividend check, this is still

very much in your interest.

To start, of course, with what the President was trying to accomplish, the President in his Jobs and Growth Initiative was trying

to provide near-term growth insurance for the economy while also

being consistent with very good long-term tax policy. This policy toward bolstering the economy in the short-term and the long-term,

we believe, helps America’s seniors in important ways.

To start with, as you made, Mr. Chairman, the point in your

opening remarks, ending the double tax on corporate income directly benefits seniors who receive dividend checks. About half of

all the dividend income in the U.S., whether it is measured just as

total dividends or dividends that would be excludable under the

President’s proposals, goes to America’s seniors, who often, as you

indicated in your example, Mr. Chairman, rely on those checks for

a steady source of retirement income.

It is also important to note that even among seniors, low- and

moderate-income seniors benefit. About 40 percent of seniors with

incomes below $50,000 receive dividend income, and, of course, seniors generally benefit from overall relief.

But just as important as this increasing after-tax income is for

seniors and reducing double taxation, it is important to tell a story

of why this is so much in our economy’s interest. When we double

tax something, like double taxing corporate income, the burden

gets borne somewhere, and surprisingly, who pays it is all of us.

It is not just who gets dividends, but all of us in terms of our

wages.

To see this, if we double tax corporate income, we raise the tax

burden on capital, we get less investment in our economy, and ultimately lower wages for all of us. For this committee, Mr. Chairman, as you think about aging policy, there is no variable more important for the long-term integrity of the Medicare program or the

Social Security program than our economy’s capacity to grow.

These are very important long-term issues for seniors.

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There is an important long-term piece of good news to start out

with, as well. The American economy has very strong fundamentals. Those don’t come from the sky. They result from the flexibility

of the American private sector and from public policies that try to

promote flexibility in capital accumulation in the consumer.

To get to the here and now reasons the President was so bold in

his growth package, I think it is important, if I might, Mr. Chairman, to say a bit about the current economic situation. We all

know where we are and we all know that events of over-investment

in the late 1990’s, the terrible tragedy of September 11, corporate

governance scandals, have placed a cloud on the nation’s economic

activity and recovery. A good chunk of what makes this particular

episode in our economy different is the pattern of business investment.

In a typical recession and recovery, investment drops and then

sharply rebounds. In the current recovery, we are seeing a lagged

and delayed recovery of investment. As I travel across the country

talking to business people, as I am sure you do, as well, you hear

stories of very high hurdle rates, very high bars placed on new investment, and this is really a key drag to our economy. The uncertainty surrounding the recovery, uncertainty surrounding tax policy, is a key risk to the outlook, as well as consumers deciding, perhaps, to increase their saving a bit in the near term in response

to declines in equity values.

In response to these downside risks, the President put forth a

growth package which would shore up consumer incomes, the acceleration of the marginal rate cuts you have already enacted, increasing small business investment incentives through expensing,

and importantly, eliminating the double tax on corporate income,

not just on dividends, but on corporate income generally.

We believe that these proposals will help the economy a great

deal in the near term. To those who say that the corporate income

double taxation has no short-term effect, I beg to differ. Most of my

professional career has been spent studying investment, and I believe it is fair to say that the bulk of research on this topic would

suggest very large effects on the cost of capital of what the President is doing.

To be concrete, were the President’s proposal to be enacted by

you in its entirety, the cost of capital for investment could fall by

as much as 10 to 25 percent, depending on the life of the equipment we are talking about, and that is equivalent to an investment

tax credit of between 4 and 7 percent. That is very big. This is perhaps the most radically pro-investment tax policy in decades.

In addition, of course, the President remains very focused on job

creation in the short run. The President’s proposal would get $58

billion into the economy in 2003, and that is the down payment on

a long-term tax cut with very large projected responses from consumers.

I think it is important to close, if I might, again with a couple

of longer-term obligations. One, of course, ultimately, economic policy, whether it is in the short-term or the long-term, has to be

about our economy’s fundamentals. The best way to tax capital

from a purely economic perspective is not to tax it at all, and again,

the reason for this has little to do with who gets dividends, alVerDate 11-MAY-2000 13:53 Apr 10, 2003 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 C:\DOCS\85624.TXT SAGING1 PsN: SAGING1
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though that is important, too, and everything to do with all of our

wages. The person who writes the check to the IRS is not the person bearing the burden of the tax.

The final point I would raise is there is caution, and rightly so,

as we think about the nation’s fiscal health going forward. The

President’s budget remains very committed to restoring fiscal

health through pro-growth tax policies and through spending restraint. It is important to look at a fiscal anchor, and to me, as an

economist, a good fiscal anchor is our country’s debt-to-GDP ratio,

which, again, is not rising as a consequence of the President’s proposals.

Are the current deficits welcome? No, of course, they are not. Are

they understandable? We know they are, and the administration’s

pro-growth plans have a way to get out of them.

I will just close with you, Mr. Chairman, with the observation

that were the President’s proposals to be enacted, we believe the

level of GDP would rise by almost a percentage point in 2003, and

by the end of 2005, be close to 2 percentage points higher and remain so. So going back to Senator Hatch’s observations when we

started, this is a permanent feedback in Federal revenue from

higher economic growth.

Thank you very much, Mr. Chairman.

The CHAIRMAN. Dr. Hubbard, thank you.

[The prepared statement of Mr. Hubbard follows:]

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The CHAIRMAN. Ms. Kramer, before we turn to you, let me turn

to my colleague from Oregon who has just joined us for any comments he would make to make in opening statement, Senator Gordon Smith. Gordon?

STATEMENT OF SENATOR GORDON SMITH

Senator SMITH. Thank you, Mr. Chairman. I am pleased to be

here and honored to be on this committee. I think the topic we are

discussing today is very important because of the simple, logical

conclusion you can reach, that if you tax something, you will discourage it, the activity you tax, and if you tax it twice, you will

doubly discourage it. I think whether it is dividends or taxing Social Security twice, which is another double taxation in our system,

we ought to, as a matter of whether you call it stimulus or just to

improve tax policy, we certainly ought to pursue this.

For several Congresses now, Mr. Chairman, I have introduced a

bill that ends the double taxation on Social Security benefits that

was begun in the Clinton Administration in 1993. My colleagues

probably know that senior citizens pay Federal taxes on a portion

of their Social Security benefits if they receive additional income

from savings or from work, and this is something that if we are serious about helping seniors to be able to provide for themselves, we

ought to end this practice and encourage work and encourage saving. I am going to introduce that bill again in this Congress, Mr.

Chairman, and certainly invite my colleagues’ support and cosponsorship.

I have a more lengthy statement I would like to include in the

record, Mr. Chairman. In the interest of time and hearing Ms. Kramer, I will just do that and look forward to her testimony.

The CHAIRMAN. Thank you very much, Senator.

[The prepared statement of Senator Smith follows:]

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The CHAIRMAN. Now, let me turn to Ms. Hilary Kramer, who, if

you have caught her on Fox News, is an open critic, an outspoken

critic of double taxation, and so we thank you very much for being

with us. Please proceed.

STATEMENT OF HILARY J. KRAMER, SENIOR STRATEGIST AND

ADVISOR, MONTGOMERY ASSET MANAGEMENT, AND BUSINESS COMMENTATOR, FOX NEWS CHANNEL, NEW YORK, NY

Ms. KRAMER. Thank you. Mr. Chairman and members of the

committee, I am very, very thankful that you invited me to testify

on the relationship between corporate governance and the double

taxation of dividends. It is extremely important at this moment in

our nation’s history that we take care of abolishing the double taxation on dividends because it is contributing to problems with corporate governance and we cannot once again go through another

round of WorldCom, Enron, Adelphia. We cannot afford that and

we need to see our stock market come back up.

But most important, we need to protect senior citizens and give

them another option, and the option is—the option would be dividend-yielding stocks, and this gives them as asset that can grow

and income going forward.

How does it work today? Today, we encourage companies to keep

the money they have earned. Instead of issuing dividends to shareholders, what we do is we have this inefficient system in which

senior management has been able to exercise creative control over

the financial results they report to the public and has provided

them the freedom to stray and wander away from their core competencies. Abolishing the double taxation on dividends is about

keeping companies honest, competent, and resourceful and allowing

shareholders to enjoy the financial returns that they deserve as

owners of the companies.

With a reduction in the taxation of dividends, the interest of corporate management would become better aligned with the interest

of shareholders. Right now, the way it works, a significant portion

of management compensation in companies today is through stock

option ownership rather than actual ownership of shares. Since an

option holder doesn’t receive a dividend but instead receives all his

benefits, or her benefits, from the appreciation of the stock, the interest is to take extra cash in the company and try to invest it in

whatever kind of enterprises could create the hype that could create a stock price to go up.

Where have we seen this? Everyone can talk about United Airlines and U.S. Airways and talk about the fact that the aviation

industry is broken and the model doesn’t work. As far as I am concerned, United Airlines twice has made the same mistake. They

took the money they made in the boom days of the late 1990’s and

they spent it on fractional jet aviation ownership companies, spent

it on the Internet. They did it in the 1980’s by deciding to become

a hotel chain company, buying Westin, buying rental car companies. We can’t see this happen again. It would have been much

more beneficial if the money had been careful used and given to

shareholders to decide if they wanted to go and rent a car. That

is the way it needs to work.

31

Moreover, companies also use the cash to buy back stock or simply to hoard it for future opportunities, like with Microsoft. In

many cases, none of these actions is as good for shareholders as

would be receiving a dividend and having the discretion to spend

it as we need. But with the current punitive tax treatment of dividends, management has significantly less pressure to change this

damaging and negative behavior.

Finally, with the present double taxation of dividends, most companies have a major incentive to raise a significant amount of debt

and, therefore, have unhealthy balance sheets. So it is not just

companies going into bankruptcy because of accounting fraud, but

you have companies that weren’t prepared for the downturn and

that is the problem. So companies like K-Mart, for example, and

what we have seen in the retail space, Montgomery Ward, Bradley’s, there is a whole list of them, and we keep hitting new records

of bankruptcies across the board.

The bottom line, implementing President Bush’s tax reform proposal promises wide-scale impact on the stock market. It will help

boost stock prices, encourage more responsible investing, strengthen corporate governance and responsibility, provide investors, especially senior citizens, with income, and with long-term ownership

and the opportunity to make money because the stock itself can go

up in value.

Plus, we need to never have a stock bubble like we have now because we are still going through the correction and we are still paying the price today, and I am out there talking to people all the

time and senior citizens especially are hurt. They are hurt, their

portfolio is down, and many are broke. Just go to retirement areas.

I was just in Palm Springs at a conference. I go to Florida. You

know what? I see 85-year-old people at the cash register instead of

enjoying the fruits of their labor and the work that they have done.

Now, on the positive side, and I think it is important to end on

the positive side, history proves to us that our country and our

stock market is about dividend-paying enterprise, and when we

look back—I took a look and I have done research and I have made

analysis on this. If you look at companies that are around 50 years,

100 years, they pay dividends, where prosperity is integral to dividend-paying companies.

For example, Johnson and Johnson, over 100 years old, a 1.5 percent dividend yield. Bristol Myers, 4.8 percent. General Motors, 5.5

percent. J.P. Morgan Chase, 5.8 percent. Another point with this

is the reason J.P. Morgan Chase is going to make it through their

problems, through their clouds of uncertainty, is that shareholders

know they are going to receive a check in the mail, and that is

what matters at the end of the day.

So dividends don’t lie and it is very important senior citizens

have other options besides a 1.5 percent C.D. Thank you. Thank

you.

The CHAIRMAN. Ms. Kramer, you lived up to expectations and we

thank you very much for that.

[The prepared statement of Ms. Kramer follows:]

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The CHAIRMAN. Let us go through a round of questions with the

panel and get your responses to a variety of our concerns.

Dr. Hubbard, the President talked about how the proposal of

ending the double taxation of dividends was especially good for seniors, and while I am not an investor in any major way, I do know

that in studying it a bit, you hear investment advisors talk about

active and aggressive investments during your earning years and

as you become more senior, you shift your assets in your portfolio

and you move to much more stable, secure investments and dividend-earning capacity. When you leave the job market, that is

where the largest portion of your investment ought to be.

My questions are, is that a true pattern with most seniors as

they move toward retirement and as they shift their investment,

and do you agree that these figures that I have offered that Cato

has come up with are accurate as it relates to seniors and as it relates to investment dividend to their income? Last—that would be

two questions. The other one would be, can you tell us the average

dividend income and the average potential dividend tax savings per

senior?

Dr. HUBBARD. Sure. Just to take up your questions in turn, Mr.

Chairman, it is, of course, true that seniors, on average, have higher levels of assets because they have been saving for their retirement, and as you pointed out, often more conservative portfolios as

they become elderly, which makes them particularly benefiting

from the President’s proposals.

If you look at Treasury estimates of who is paying the dividend

tax now, about $37 billion in dividends that are currently received

by seniors would become tax-free. There are more than that received by seniors, but that much would be excludable. As you noted

in your opening, more than half of the seniors are getting excludable dividends.

It might interest you to know that if you look at the seniors making under $50,000, and then I will get to your more general question, roughly five million tax returns in that area, would still get

about $1,500 in dividend income and save a few hundred dollars

a year, and this is just the seniors making less than $50,000. Obviously, higher-income seniors would benefit more.

If you look at the totality of what the President is proposing, the typical senior would get an average tax cut of about $1,400. So this

is actually quite substantial.

Your question about the OECD numbers, it is quite correct that

for equity-financed investments, the U.S. has a punishing tax system. There is really no other country in the G–7 that fails to provide some sort of relief for double taxation, so this is a real problem. It shows up, as Ms. Kramer was saying, in biasing toward

other kinds of investments that expose the economy to financial

fragility. It makes our companies less competitive abroad as well

as at home. So these are all very important issues the OECD study

raises.

The CHAIRMAN. I thank you.

Ms. Kramer, while I am going to work mightily to keep this focused on the impact on seniors, because that is the guide and the

direction of this committee, we also understand the impact of the

economy on seniors and the reality of declined incomes for them.

44

You have mentioned, and, therefore, having to shift lifestyles, and

we are not talking about wealthy people, but people who have

saved all of their lives to build a nest egg to gain those rewards,

and then to have the difficulty of seeing them disappear and/or

substantially be reduced.

In your testimony, you have listed several critically important

corporate governance advantages from the President’s dividend

proposal. Can you think of any disadvantages for corporate governance if Congress ends the double taxation of dividends?

Ms. KRAMER. No. There would be no disadvantage to ending it.

The concern we keep hearing is concern about what would be lost

in terms of tax revenue, but that would be more than made up for

in terms of a stock market that would rise quickly, and we have

lost $8 trillion dollars of wealth in the stock market, right? We

have gone from $18 trillion to $10 trillion. We would make up that

$300 billion and whatever possibly could be lost immediately.

In terms of disadvantages, there are none on the corporate governance level because we would get everybody on the same page,

the shareholder, senior management, and the boards of directors.

The CHAIRMAN. You would still have in the economy, obviously,

startups and venture capitalists and all of those kinds of things,

and once that company began to grow and build its base and do

all of that, and this is obviously showing my ignorance, I am assuming the transition occurs at a point of profitability and a strive

to gain profitability.

I am looking at Microsoft, sitting there with the hugest bucket

of cash of almost any corporation in America, never having paid

dividends. I found it fascinating that after the President’s proposal,

they are now talking about dividends. Is that a reaction to, or have

they simply come to a point in time where to secure investment,

they feel they have got to start rewarding the investor beyond stock

value?

Ms. KRAMER. There is an absolute correlation, Senator, because

Microsoft understands with their brilliant management team that

with a tax cut, with the abolishing of the double taxation of dividends, investors will want to buy Microsoft shares to get that dividend. There is $43 billion that needs to be paid out.

Also, Microsoft has lost money by, again, not sticking with core

competencies. For example, they went and invested in a cable company in Brazil. Now, I would have much rather have a dividend

than to know that Microsoft went, made this investment in a saturated market in an area where they couldn’t make money, they

have lost all their money, and me, as a shareholder in Microsoft,

would prefer that dividend. Microsoft understands that, and Bill

Gates, yes, he is to gain $100 million in taxes he won’t have to pay,

but so is the shareholder who owns one share, or the person who

owns it through whatever pension fund they might have.

The CHAIRMAN. Thank you. Let me turn to my colleague from

Louisiana, Senator Breaux.

Senator BREAUX. Thank you, Mr. Chairman. I thank the panel

for their presentation.

Dr. Hubbard, you had indicated and were trying to make the

case that the President’s dividend tax elimination proposal would

be good short-term stimulus to the economy. Alan Greenspan disVerDate 11-MAY-2000 13:53 Apr 10, 2003 Jkt 000000 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 C:\DOCS\85624.TXT SAGING1 PsN: SAGING1
45

agrees with you, and vocally and, I think, very strongly. While

elimination of the double taxation on dividends is good tax policy

in the long-term, which I agree, in the short-term, it is not stimulative at all. He points out that over 62 percent of dividends that are

declared are not taxable now because of the fact they are going into

pension funds, retirement funds, and tax-exempt funds.

But on the question of short-term stimulus, I can’t think of anyone that is probably more respected by Democrats and Republicans

than Mr. Greenspan and he doesn’t agree with your statement on

it being a stimulus in the short-term. What would you tell him?

Dr. HUBBARD. Certainly, Senator, I think first to your point

about the dividends that are received currently by exempt entities,

what matters for the cost of capital asset prices is in econ-speak

the marginal investor, and almost all the evidence we have in finance is that that is a taxable entity. So even if the bulk of dividends went to tax-exempts, that would have little to do with the

pro-investment aspects of the argument.

I suspect that a lot of this is over what the word ‘‘stimulus’’

means. It is certainly the case the President does not view government’s job as fine-tuning the economy, and when people say the

word ‘‘stimulus,’’ that often is what comes to mind. But go back to

the diagnosis I mentioned that the President believed that was the

problem, which was this delayed investment recovery. That is very

much centered on hurdle rates and costs of capital, and there,

eliminating the double tax has a very large effect on the cost of

capital. I can’t comment on remarks I didn’t hear——

Senator BREAUX. OK. Well, let us assume that is what he said,

for the sake of argument. Does the White House say that Alan

Greenspan is wrong in his belief that dividend tax elimination is

not short-term stimulus?

Dr. HUBBARD. Again, the way I would put it, Senator, is we believe that the dividend tax proposal lowers the cost of capital now

and in the future.

Senator BREAUX. Is it short-term stimulus?

Dr. HUBBARD. I don’t like the word ‘‘stimulus.’’ More importantly,

the President doesn’t because it has this fine-tuning feel to it. I

think what we believe is that——

Senator BREAUX. When you all first proposed the program, it was

a stimulus package. It was going to be short-term, it was going to

be stimulus, and over half of it was going to the elimination of the

double taxation on dividends. Greenspan says that is not shortterm stimulus. Does the White House disagree with Mr. Greenspan?

Dr. HUBBARD. We believe that the dividend tax part of what the

President is doing is good for the economy generally. It is good in

the short-term, it is good for the long-term. In economic policy, you

can’t so nicely put things into short-term and long-term boxes. It

is a policy that, over time, gets even better. So in that sense, it is

a long-term policy. But it very much would be pro-investment in

the short-term, as well.

Senator BREAUX. So you disagree with him, then, in that regard?

If he says it is not short-term stimulative to the economy, the

White House disagrees with him, then.

46

Dr. HUBBARD. Yes. I can’t comment on words I didn’t hear and

terms that I wouldn’t use, but I think what I can say to you is a

very straight answer. We think this lowers the cost of capital in the

same way that a quite significant investment tax credit would, and

it is hard for me to believe that is not pro-investment today and

in the future, and this, again, is coming from somebody who has

studied this for many, many years.

Senator BREAUX. You sort of dodged the question. [Laughter.]

You have done your best. I agree that the estimates that I have

seen is that a large portion of the tax package does affect seniors,

and I think that is a fact. It seems that nearly 15 percent of the

total tax cut benefits, in what they are now calling a growth package as opposed to a stimulus package, go to filers who are over the

age of 65. But while that, I think, is positive, it also has to be fair

in who it goes to, and thus the concern that I have.

I look at Louisiana, my State, and only 8 percent of the working

people end up paying taxes on dividends. When you get to retired

people over 65, the number drops exponentially lower than even 8

percent that are affected by any dividend tax elimination at all.

The information I have seen is that about 14 percent of the total

tax package benefits go to people who are over 65 with incomes

over $1 million. I don’t know if there is a single person in Louisiana that would fit that category. Maybe, but you could probably

count them on one hand.

Over 60 percent of the benefits in the total package go to elderly with incomes over $100,000. Now, my State has an average income

of working people of about $22,000. We are talking about basically

retired people, where over 60 percent of the benefits go to those

who are retired making over $100,000 a year. From my standpoint,

spending that much money, it has to hit the largest number of people possible.

On the dividend income, nearly 43 percent of the benefits of the

dividend exemption that go to elderly individuals go to those with

incomes over $200,000, on the dividend exemption. Again, I don’t

know how many in Louisiana I have in that category, but I will tell

you, you can count them on one hand or two hands, probably. It

is not a lot.

So I am just concerned that while we are spending a lot of money

and it is affecting a lot of people—you point out that—you said that

the average cut, I think, was almost $1,400, the average tax cut for

seniors. The average cut for seniors, 13 million elderly would receive a tax cut of about $1,384, but almost 80 percent of them will

get less than that amount. We can play numbers and statistics and

averages. If you take the average, that is probably true. But almost

80 percent would get less than the average, with about 40 percent

getting something like $100 or less from the proposal.

Now, I have laid out a lot of facts on the other side of what you

have said and I would ask you to comment on them.

Dr. HUBBARD. Certainly, Senator. I think there are really two

key responses to your question. One, just to play the traditional

game of distribution tables, and I won’t go through all the numbers. I think your question raises important points—— Senator BREAUX. Do you disagree with any of the factual numbers I used?

47

Dr. HUBBARD. Some of the numbers are—— Senator BREAUX. Which ones?

Dr. HUBBARD. Well, I can work with you on that because I have

some Treasury data, but the patterns you are mentioning are accurate, but I would say two things. One, if you look at the distribution table as it is currently done in Washington, before and after

the President’s plan, it looks almost the same in terms of share of

tax burden, because the President’s plan has a great deal in it for

low- and moderate-income families. But that is not the point.

As I tried to say in my remarks, what is really surprising as the

economic result here is when you spoke well of working people, you

were exactly on the point. Who ultimately bears this tax is working

people, even if they never get a dividend. This isn’t about who gets

dividends today. It is about the wages of everybody in the future,

whether they are seniors or all of us as we are getting lower. That

is the surprising result of economics. That is what the President is

focused on. Yes, it affects seniors today, but the real issue here is

our country’s productivity and long-term growth. That, to me, is

the biggest fairness question.

Senator BREAUX. That will be the argument. I mean, a worker

that is making $22,000 in Louisiana is not going to feel that comfortable and feel that he is getting a lot of benefits from a retired

person who has an income of over $200,000 getting 43 percent of

the dividend tax exemption value. That is not going to make that

person with a family of four feel very good as he struggles, that I

am going to really benefit because someone over 65 is getting 43

percent of the value of the dividend exemption and he is making

over $200,000 in retirement income.

Dr. HUBBARD. But, Senator, you are not benefiting as a working

person because the older, more affluent senior is getting dividend

checks. You are benefiting because that is leading to greater capital

accumulation in our economy and higher wages. I understand that

that does not fit—— Senator BREAUX. I am going to bring you with me to sell that

point in Louisiana and see what kind of reaction you get. [Laughter.]

Thank you very much.

The CHAIRMAN. Let me turn to my colleague, Gordon Smith from Oregon, but before I do, is that $22,000 a year working man or

woman in Louisiana with a family of four paying any taxes under

the current—— Senator BREAUX. Hopefully not. Some of the points of the President’s package are good.

The CHAIRMAN. Yes.

Senator BREAUX. I mean, the child exemption credit is good. The

marriage penalty is good.

The CHAIRMAN. Actually, that family gains more under the President’s package than the seniors we are talking about here, the

$1,400, if they are getting the child tax credits.

Senator BREAUX. I don’t know the number on that. We could take

a look at it. It is—— The CHAIRMAN. Very close to it.

Senator BREAUX. The question, though, and the whole point, obviously, is fairness.

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The CHAIRMAN. Yes.

Senator BREAUX. If we are going to spend that much money on

a dividend tax exemption, in my State of Louisiana, only 8 percent

pay any tax on dividends.

The CHAIRMAN. OK. Let me turn to my colleague from Oregon,

and then we will turn to Senator Carper if he wishes to make an

opening comment. Gordon?

Senator SMITH. Thank you, Mr. Chairman, and I want to thank

our witnesses for excellent testimony.

To Senator Breaux’s point about who pays taxes, it is a fact that

many of these dividends, as they are currently going out, are already sheltered because they are in pension funds. They are sheltered until they are pulled out. So you could argue it is not stimulative in that sense right now.

That raises for me a question I have had ever since this was proposed. I understand why, politically speaking, it makes a lot of

sense to end the taxation at the individual level, but I wonder if

you can comment as to the efficiency of markets, whether it makes

more sense to end it at the corporate level and then perhaps give

some of what we had before the 1986 Tax Act, some allowance for

deductibility, though not full deductibility, to individuals. Is there

a way to, in fact, increase the efficiency of this proposal? Ms. Kramer?

Ms. KRAMER. Senator, because the stock market, because the

economy is all emotion, it is pure psychology, it makes sense that

it really has to be on the individual level, because an individual investor has to feel the benefit of having more money in their pocket

and that is the bottom line with that. Now—— Senator SMITH. Your point, I would assume, is even though the

corporation still pays the tax——

Ms. KRAMER. The corporation—— Senator SMITH [continuing]. The board room will feel the heat because the shareholders will be demanding the dividends.

Ms. KRAMER. The shareholder will demand the dividend. The

stock market needs to go back up. We need—we have very serious

systemic problems right now, and if we don’t fix them and we don’t

jump-start our economy, we are going to keep losing money out of

our stock market.

Yes, I agree that to a certain extent, corporations, if they were

to have the exemption on terms of the tax, yes, they would start

capital spending immediately. But no, if their stock price goes up,

companies will be in a position to start engaging in capital spending. Two-thirds of the economy is the consumer, but the consumer

is almost spent out. Interest rates are as low as they are going to

go right now. How many more mortgage refinancings can we have?

Everyone has whatever money they are going to have in their pocket and we need companies to spend.

So your argument is well taken, but at the same time, we need

people to get excited and we need that foreign money, also, back

into our stock market, because it keeps going out and companies

can’t spend and we need them to invest in high-tech and get out

there and upgrade all their systems.

Senator SMITH. Mr. Hubbard, did you all consider the corporate

proposal as opposed to the individual proposal?

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Dr. HUBBARD. Yes, Senator. I don’t think it is politics so much

as the principles in economics. If you think about it, if everybody

paid the same rate of tax, say the corporate rate were the same as

individual rates, nobody was tax-exempt anywhere, it really

wouldn’t matter in the simplest world whether you took the double

tax away at the corporate level or the individual level.

But, of course, there are a lot of tax-exempt and foreign shareholders and I think what the President said in his rhetoric is no

double taxation. That means tax it once, not tax it not at all. To

do that in the current environment would require individual relief.

It also has the very important benefit that Ms. Kramer mentioned,

which is in corporate governance. It really is a discipline to management to have to go to the capital markets to be monitored

whenever new money is needed, to try to pay money out of corporate solutions.

So I think the reasons to do it are entirely principled, although

there are certainly good arguments for doing it at the corporate

level, as well.

Senator SMITH. How about a combination of both? Was that ever

considered?

Dr. HUBBARD. I don’t think, again, you would want to do both in

the sense that the goal here is to tax once and only once.

Senator SMITH. Hilary, you mentioned that we are competing

against foreign nations, as well, and we have capital flight now, apparently. What is the policy in Europe, generally? What is the policy in Asia, generally, in terms of the taxation of dividends?

Ms. KRAMER. Well, we have the second-highest, the United

States, taxation on dividends, only next to Japan. So Europe, the

rest of the world, got savvy to this long ago, long ago.

By the way, foreign companies that trade on our stock exchange,

Senator, in the form of ADR, American Depository Receipts, they

have gotten savvy to this. They are sort of looking from a distance

and have realized the importance and significance that abolishing

the double taxation dividend will have on raising their stock price,

so they have jumped ahead in increasing their dividend. I have

seen companies. Elbit Systems, Royal Dutch Petroleum, Unilever,

British Petroleum, take a look at their dividend yields compared,

let us say, ‘‘To Exxon or Mobil and you will see that they know

what is going on because they have experienced it themselves outside of the United States.’’

Senator SMITH. I see this chart now. I think, Mr. Hubbard, you

all have started a very important debate. I hope you will continue

with it. Whether it is part of a stimulus package or not, I don’t

know at this point what is possible to get through the U.S. Senate,

but eventually, this needs to happen for the sake of our markets

and our system in the United States, in order to be competitive

and, frankly, in order to pursue what will be much more productive

tax policy. So if not in this Congress, I hope as soon as possible,

and a lot of us are anxious to help you win this fight. Thank you.

The CHAIRMAN. Thank you very much, Senator.

Now let me turn to Senator Tom Carper of Delaware. Tom, welcome.

Senator CARPER. Mr. Chairman, good morning.

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The CHAIRMAN. Opening comment and/or questions, your pleasure.

STATEMENT OF SENATOR THOMAS R. CARPER

Senator CARPER. First of all, let me say welcome to both of you.

We are delighted that you are here and we thank you for your testimony and for your response to our questions.

Before I was a Senator, I was a Governor, and I was privileged

to be Governor of Delaware for 8 years. I inherited an economy

that was in recession and we came out of that and had eight very,

very good years. I was Governor when it was easy to be Governor.

I used to say, ‘‘With an economy this strong, even I look like I

know what I am doing most days,’’ and people would nod their

heads and say, ‘‘Yes, he does look like he knows what he is doing

most days.’’ But we cut taxes, I think, 7 out of the 8 years I was Governor.

We always had a litmus test for our tax cuts. One, they had to be

stimulative to the economy, really, I think arguably, each time, create more jobs. We wanted to simplify the economy, so we didn’t

want to make it more complex; so that was another piece of our litmus test. I always wanted to make sure that the tax cuts were reasonably fair and broad-based. The last element of our litmus test

was to say that we wanted to be able to sustain a balanced budget,

so we didn’t want what we were doing to unbalance our budget.

I was elected State Treasurer back in 1976 at the tender age of

29. Pete DuPont was elected Governor that year. About a month

or two later, we ended up getting the worst credit rating in the

country. Pete DuPont’s first State of the State message said Delaware is bankrupt, and he was trying to get the legislators to focus

on the spending side. They really didn’t focus that much, but the

folks up on Wall Street focused a lot and they lowered our credit

rating the next week to the lowest in the country, and we were

crowded out of the credit markets.

We had the worst credit rating in the country, tied for dead last

with Puerto Rico. They were embarrassed to be in our company.

When I stepped down as Governor, we had gotten a AAA credit rating, so I am somebody who thinks a little bit about these issues

and have worked a little bit in these vineyards.

I want to ask a couple of questions, and just be thinking about

these. First of all, when we issued the debt in my State, we could

issue it as a credit rating B–AA–1, which is what we were in 1977,

to today having a AAA. As you might imagine, it makes a difference, what your credit rating is. One of the questions I want to

ask, but not just yet, is what effect will the President’s proposals

have on issues of tax-exempt bonds, State, local governments, counties, cities, so forth, school districts?

Second, I want to just kind of go back and look at the last couple

of years. I say this not as an economist, because that is really your

specialty, but I have studied a little bit in that area and I am fascinated by getting the economy moving and cycles, economic ups

and downs.

Mike Castle, who was our Governor, succeeded me as Congressman—I took his job in 1992 as Governor as we kind of swapped

places. He now serves as our Congressman. We were invited back

51

by the Delaware Business Roundtable last month to speak to them

like we used to do when we were Governors. One of the questions

I asked of all the CEOs there from Delaware businesses, including

some pretty big businesses, I said, ‘‘What do we need to be doing,

Congressman Castle and myself, to help in our jobs in Washington

to get the economy moving?’’ The President had just laid out his

proposal and I was looking at them to comment on the proposal.

They didn’t really have much comment on the President’s proposal, which had just literally been put on the table, I think, the

day before. They talked a lot about uncertainty, though. They

talked about the fact that while the elections were over, that uncertainty was behind us, the uncertainty with respect to Iraq, the uncertainty with respect to North Korea are still with us. We talked

about the uncertainty that still flowed out of potential terrorist attacks or reprisals, whether we went to war with Iraq or did not.

Several of them raised concerns about uncertainty with respect

to the stock market and what were we going to do with the SEC,

who is going to be the head of the SEC, will they be tough and will

they restore investor confidence? A couple of them talked about Afghanistan.

A number of them talked about health care costs and how their

health care costs for their employees and health care costs for their

pensioners were really hurting them on their bottom line and those

were the issues they talked about. I couldn’t get them to talk a lot

about tax cuts, but they talked about those other issues and they

really focused on uncertainty.

We have cut taxes in 2001 by a fair amount. We cut them again

by not as much in 2002, and the administration has come forward

with another proposal to cut taxes in 2003. What I am hearing

from some of our business folks is the idea of trying to do away

with the double taxation of dividends, which I think is laudable

could be done in a better way. Some folks say, ‘‘You ought to let

businesses expense their dividend payments just as they do their

interest payments.’’ So I am not sure what is the best way to do

it, but I think in the context of overall tax reform, it actually

makes pretty good sense.

Some folks on my side, Mr. Chairman, complain about the tax

cut proposal and say, ‘‘Well, there they go again, unfair, class warfare, helps the rich, doesn’t help the middle-income folks.’’ As it

turns out, wealthy people actually do pay a lot of taxes. If we are

going to get some tax cuts, they are going to get some of the benefit, and I think it is hard to argue with that.

That was kind of my opening statement, Mr. Chairman. [Laughter.]

What I would now like to do is just ask a couple of questions,

and I will go back to the first one and I will telegraph the others.

The CHAIRMAN. The Chairman will be tolerant and lenient, especially in light of the last portion of your overall comments. [Laughter.]

Senator CARPER. Thank you, Mr. Chairman.

The CHAIRMAN. Please proceed.

Senator CARPER. Thanks a lot. I want to ask you to take up with

me the effect of the issue of tax-exempt bonds. States are struggling. My State is not in as bad of shape as some others, but some

52

of the States are just getting killed right now and they are looking

to us to help them on their health care costs, they are looking for

us to help them fund No Child Left Behind, they are looking for

us to help them on funding first responders and all that stuff. But

talk first about the effect of this proposal, eliminating the double

taxation of dividends, how will that affect issuers of tax-exempt

bonds? When they come to us and say, ‘‘God, help us, don’t do that,

that doesn’t really help us,’’ what do we say? What do you say?

Dr. HUBBARD. Let me start, if I might, with a story I told the

Bond Market Association on the same question. Suppose we were

all sitting in 1975 and I told you that I had perfect foresight, I

could tell the future, what is going to happen to marginal tax rates

over time, what is going to happen to financial innovation. If I told

you that future and you were in the muni bond business, you

would have grabbed your chest and run for the door because there

would have been big see-saws and tax rates and—— Senator CARPER. What year?

Dr. HUBBARD. Nineteen-seventy-five, but you can pick another

year if you like one better.

Senator CARPER. That is a good one.

Dr. HUBBARD. But just the notion there that there are major

changes in tax rates that have not had overly adverse effects on

the muni bond market.

To your question, if you are a State, there are really three things

at issue here. One are the yields on muni bonds. The second is the

effect on your tax base if the Congress went along with the President’s proposal and exempted dividends. and the third would be

the effects on economic growth and State revenues. Let me start

with the last and work back.

We have estimated at the Council that State revenues would be

higher by about $6 billion a year. Most States are a little more

than one-for-one responsive to State income. We have done this

State-by-State. I don’t have Delaware on the top of my head, but

I would be happy to get it for you.

Muni bond yields, we feel, would go up by minimal amounts. The

largest effects we have been able to get would be 10 to 15 basis

points, and that is from both the acceleration of the marginal rate

cuts and eliminating the double tax, which is just to say our capital

markets are very liquid, indeed. So I know this concern is raised

and it is important to raise the concern, but it is also important

to net that against growth effects that we believe are much, much

larger.

Senator CARPER. All right, good.

Ms. Kramer, any comment at all on this one? You can take a

pass if you want.

Ms. KRAMER. Have you been to Knott’s Berry Farm? It is an

amusement park.

Senator CARPER. You know, I have not.

Ms. KRAMER. OK. The company is Cedar Fair—— Senator CARPER. California, right?

Ms. KRAMER [continuing]. Ticker FUN, F-U-N. Actually, they are

based in Sandusky, OH, a 7.5 percent dividend yield, and a company that is 140 years old that has served six, seven, eight generations of families. When people go to Cedar Fair Park or Knott’s

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Berry Farm, they are still going to drive on the roads and they are

going to pay the tolls and they are still going to use whatever city

services, State services. I mean, the pie is only going to get bigger.

People are still going to buy municipal bonds. I am still going to

have municipal bonds in my portfolio and I am still going to recommend it as an important part of everyone’s portfolio core holding.

Now, any issues with municipal bonds and any potential problems in the future, Senator, may not have anything to do with abolishing the double taxation on dividend. It is going to have to do

with the fact that people are paying less State taxes because there

are more people that are unemployed and there are companies that

are not doing well and they are not selling their products as fast

and as profitably as they had in the past. Thank you.

Senator CARPER. Thank you. The other question that I tried to

telegraph, and let me just come back to it, and someone may have

raised it before me, and if they have, I apologize, but there are a

couple of different ways to skin this cat. Some have said, ‘‘No, the

way the President wants to do it is probably not the best way.’’ The

best way to do it is to allow corporations who have a dividend to

expense those dividend payments like they expense their interest

payments from their debt.

Could you just comment for me, I am sure you considered that

as an option, and just maybe the relative merits of either approach

and why you chose the approach you have chosen?

Dr. HUBBARD. Sure. It did come up, but I would like to go over

it again with you, with Senator Craig’s indulgence. Basically, the

Business Roundtable for the country, and I can’t speak for the business people you spoke with, but the Business Roundtable has endorsed the way the President did his plan for removing the double

tax, and I think from the President’s perspective, this reflected a

principled concern that you only want to tax income once. It turns

out if that is your principle, you are really driven to do this at the

individual level, because if you do corporate-level relief, you won’t

tax much of the income at all because it will simply flow to taxexempt or foreign shareholders. So the President was very serious

in sticking to that principle.

It also provides very important corporate governance benefits, because facing the judgment of the capital market, paying out funds

and having to go back to the capital market if you have a good

project, is discipline that I think many corporate finance specialists

would believe is heartily needed in corporate America.

Obviously, removing the double tax is, we believe, very important. There are many ways to do it, but those were the principled

reasons the President picked his way.

Senator CARPER. Maybe one last comment, Mr. Chairman——

The CHAIRMAN. Please.

Senator CARPER [continuing]. I will be done. My mom is 80 years

old and she doesn’t have much in the way of investments, but she

has a few. She has Alzheimer’s disease these days and she is not

really cognizant of really what she has, but she has two grandsons.

I will never be able to have this conversation with her because of

her condition, but it would be interesting to ask her, Mom, how

would you feel about not having to pay taxes on dividend income,

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or how do you feel about your grandsons paying more taxes further

down the road because we have not done a very good job managing

our budget deficits?

I worry a whole lot about budget deficits. I know some people say

they don’t amount to much and it is not something we ought to be

concerned about, but when we went as a country from, gosh, was

it 1969 to, I want to say, ‘‘1998 or 1999 and never had a balanced

budget and finally got into a way of having balanced budgets again,

which I thought was good—and I am not one who worships at the

altar of balanced budgets.’’

Senator Craig and I, a long time ago in an earlier role, he and

I worked very hard on a balanced budget amendment to the Constitution, almost got it approved in the House, not one that mandated a balanced budget every year, but one that said if you are

going to unbalance the budget, you need a three-fifths vote in the

House, three-fifths vote in the Senate. You need a three-fifths vote

in order to raise the debt ceiling. By the way, the President had

to propose a balanced budget, which I think is maybe the most important element of all. We got it close, but we didn’t get it done.

But I don’t worship at the altar of balanced budget, though I

think it is important. I am concerned as the CBO gives us the new

budget estimates and deficit estimates for the rest of this decade

that pretty much all we see is red ink and I find that troubling.

The last thing I will say, ‘‘I had a chat with Dan Crippen, outgoing CBO Director the other day, and we talked a bit about the

impact of this proposal on the economy, or other tax proposals on

the economy, and he put it in this context, which I thought was

very interesting.’’ He said, ‘‘If you look at the economy for the next

10 years, it might be $10, $12, $14 trillion—excuse me, $120, $140

trillion over the next 10 years.’’ He said, ‘‘What you are looking at

here is a tax cut of about $650 billion over the next 10 years.’’ He

said, ‘‘Just to put it in context, and take $140 trillion versus $650

billion, it is about a 65-cent change on $140, a 65-cent impact, not

percent impact but cent impact, on $140.’’

He said, ‘‘Sometimes we delude ourselves into thinking that the

tax cuts that we make here are going to have some huge effect, but

sometimes they really don’t.’’ They make us feel better. Maybe it

is the psychology that Ms. Kramer talked about. Maybe psychology

is a helpful thing for the economy. But in terms of actually stimulating the economy, a far better stimulus is probably resolving

these uncertainties that we talked about, getting the price of oil

down and having some certainty on the price and availability of energy.

With that, I will say thank you. It was great to see you both and

we welcome your presence here. It is just a real pleasure. I read

a lot about you, Mr. Hubbard, and it is just a real pleasure to have

a chance to actually meet you.

Dr. HUBBARD. Could I actually try to answer your question, if it

is——

Senator CARPER. I didn’t ask a question there, but—— [Laughter.]

Dr. HUBBARD. You had an interrogatory——

Senator CARPER. But——

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Dr. HUBBARD. With your indulgence, because you posed what I

think is the best analogy when you raise the issue of your mother

and grandchildren. The administration obviously shares the concerns about deficits, but the human element of this is very important because this isn’t about dividend recipients. It is about the

economy’s future and economic growth, so that is precisely the

right point. We believe that the wages and the incomes of her

grandsons are going to be much higher as a result of what the

President is proposing, and that is exactly what we are about.

Dan Crippen is right. Economies are large. You don’t steer battleships easily. But what you can do is set the right environment

for growth, and that is what the President is trying to do.

Senator CARPER. My thanks to both of you. Mr. Chairman, thank

you for your indulgence.

The CHAIRMAN. Well, thank you, Senator. Tom is right. Both he

and I partnered up in the House to aggressively advocate in the

decade of the 1980’s a balanced budget, and I must tell you, I was

very pleased in the post-1994, 1995, 1996 period when we got there

with the help of some fiscal responsibility here and some great

growth in the economy. I must tell you, I would be the first to

agree with you that a $307 billion deficit budget as proposed yesterday is very perplexing to this conservative Republican. We will

work our way through it.

Panelists, thank you so much for being with us today. Dr. Hubbard, we thank you, not only for your openness, but your insight

into a broader aspect of double taxation as it relates to dividends

that I think many people miss in the overall gaming of the issue.

While this is a committee that deals with the concerns of aging

Americans, we clearly know that a strong economy is the best that

can ever happen to a senior citizen because it stabilizes all aspects

of the world around them, including their income, and that is of

real concern and importance to us, so we thank you.

Ms. Kramer, thank you for your openness, your outspokenness,

your advocacy, and keep up the issue of championing this cause.

I think it is the right cause, and in this instance, for elderly Americans, it certainly is a very important cause. Thank you.

The CHAIRMAN. Let us move now to our second panel. Please

take a seat, gentlemen, and we will proceed.

We will first start with Dick Buxton, a constituent of mine from

Idaho who will describe the impact of double taxation on his family

in Idaho.

Then we will turn to Dr. Dan Mitchell, a tax reform expert from

the Heritage Foundation.

Last, but certainly not least in all of this discussion, Dr. Mark

Crain, Professor of Economics at George Mason University and a

trustee for the Virginia Retirement System.

Gentlemen, thank you very much. Dick, please proceed.

STATEMENT OF DICK BUXTON, BOISE, ID

Mr. BUXTON. Good morning. My name is Dick Buxton and I am

from Boise, ID. I am a graduate of the United States Naval Academy, Class of 1959, and have retired as manager from U.S. West,

now Quest, and as a Captain in the Naval Reserve. Since retirement, I have worked several different businesses, to include teachVerDate 11-MAY-2000 13:53 Apr 10, 2003 Jkt 000000 PO 00000 Frm 00059 Fmt 6633 Sfmt 6633 C:\DOCS\85624.TXT SAGING1 PsN: SAGING1
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ing in the public schools. I wish to thank Chairman Craig and the

other members of the committee for inviting me to testify about the

issue of double taxation of seniors. Double taxation is basically immoral.

We face double taxation on Social Security benefits. It used to be

simple. Social Security was not taxed. But now, seniors pay a tax

of 50 percent or 85 percent of income over a certain amount. This

is not fair.

Seniors also face double taxation on dividend income. Companies

pay income tax and folks who receive dividends pay individual income tax on those same earnings, as well.

I don’t have a lot of dividend income, maybe a few hundred dollars a year. I also purchased IRAs and have some mutual funds.

It is my understanding that IRA dividends will not benefit from the

removal of the double taxation on dividends.

But my 89-year-old father, who is a retired railroad switchman

living in Caldwell, ID, depends on his dividends. He purchased

stocks such as Idaho Power, energy stocks and utility stocks, and

has income stocks to supplement his railroad retirement income.

The removal of the double taxation on dividends will be of great

benefit.

My 91-year-old mother-in-law, a retired school teacher, also depends a great deal on her dividends. She has invested in utility

and other dividend-paying stocks that provide a large portion of

her retirement income. The removal of the double taxation on dividends will be of great benefit.

Finally, when someone dies, the government taxes what might be left over. Making the tax-free limit of up to $600,000—I believe this

is increasing, and Senator Symms was kind of involved in that

when he was in the Senate, especially for people who own family

farms and small businesses. Increasing the tax-free limit will help

hold these farms and businesses together after the founder dies.

There are reasons I support the President’s proposal to give tax

relief to all Americans. His plan should open the eyes of investors

in stocks that the objective of business is to make a profit. In my

view, a major cause of the stock market decline and the corporate

breach of trust can be attributed to high degrees of speculation in

tech stocks that were losing money. Companies that pay dividends

usually have to make a profit, and most of these companies do

make a profit.

In the last few years, stocks were hard to follow. Illinois Power

became Dynergy and went from a high-dividend stock to a stock

with a big increase in stock value and later decimated. With the

debacle of Enron, many stocks in energy trading and telecommunications were decimated. These stocks, for the most part, were highly speculative. With the elimination of the double taxation of dividends, analysts should be more honest in their stock evaluation endeavors and people purchasing stock should be more aware of the

stocks they are purchasing.

I am not an accountant, but I have made a point of doing my

own taxes to more fully understand and be directly knowledgeable

of the contents of my tax return. I also do my parents’ return.

Thank you, Senator Craig and the committee, for allowing me to

testify.

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The CHAIRMAN. Dick, thank you for traveling from Boise to be

here to testify. I think it is important to recognize when we talk

about the impact on seniors, and there will be some who will speculate that this kind of double taxation issue will only affect the rich,

I doubt that your retired railworker father, is it?

Mr. BUXTON. That is correct.

The CHAIRMAN [continuing]. Views himself as a wealthy man.

Mr. BUXTON. No. Senator Carper indicated that the effect on the

States, he pays no State tax. He will benefit really from the other,

though.

The CHAIRMAN. Thank you. We will move to questions later, but

it struck me and I thought that was the valuable part of your testimony, is there a broad range of folks out there who have the potential of benefiting.

[The prepared statement of Mr. Buxton follows:]

Me graphics 32 to 33 here

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The CHAIRMAN. Now, let us turn to Dr. Dan Mitchell, tax reform

expert with the Heritage Foundation. Thanks for being with us.

STATEMENT OF DAN MITCHELL, McKENNA SENIOR FELLOW

IN POLITICAL ECONOMY, THE HERITAGE FOUNDATION,

WASHINGTON, DC

Mr. MITCHELL. Thank you very much, Senator, members of the

committee. This is a very important topic. I am glad you are taking

the time to look at it. With your indulgence, perhaps my full testimony could be submitted for the record and I can highlight some

of the things that haven’t already been covered, I think.

The CHAIRMAN. Without objection, all of your texts will be a part

of the record. Thank you.

Mr. MITCHELL. Both Glenn Hubbard and Ms. Kramer, I thought,

did an excellent job.

We do have a very serious problem with double taxation in this

country. I don’t know that it was designed to deliberately target

the elderly, but they certainly are the ones that are bearing the

brunt of the policies.

I passed on to your staff a chart that I just did yesterday, so it

wasn’t part of the official testimony, showing that if a taxpayer

spends his after-tax income, there is no additional Federal taxation

on that decision. But if a taxpayer saves and invests, that same

dollar of income can be taxed as many as four different times when

you factor in the capital gains tax, the corporate income tax, the

personal income tax, and the death tax, and that clearly is something that is bad for the economy.

Every economic theory, even Marxism, they all agree with the

notion that capital formation is the key to long-run growth and

higher living standards. It is the common sense notion of setting

aside some seed corn so you can have greater production and greater living standards in the future, and that is what I think the

President is trying to do with his tax plan, not only eliminating the

double tax on dividends, but also the policy to try to provide relief

from the double taxation for savings with the lifetime savings accounts, and, of course, 2 years ago, the elimination, at least hopedfor elimination, of the death tax.

Let me talk a little bit about how these policies affect senior citizens. The death tax, as we all know, is imposed upon a taxpayer’s

assets upon death if they have assets above a certain level. That

is clearly double taxation, maybe even triple or quadruple taxation,

because those assets were purchased with after-tax dollars.

The tax on Social Security is another example of double taxation.

Under current law, 50 percent of Social Security payroll taxes are

deductible, the corporate side. Anything above and beyond taxing

50 percent of benefits clearly would be an example of double taxation. Some people even make the argument that any tax at all

would be an example of double taxation. But certainly, what happened in 1993 shifts from neutral treatment, at best, to double taxation.

Then, of course, we have the example of the double tax on dividends. Again, I think the chart from the data put together by the

Cato Institute from OECD data highlights not only that this is double taxation, but it is very, very damaging in terms of America’s

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competitive position in the global economy, and on the issue of

what is short-term stimulus, long-term growth, I agree that those

things shouldn’t be separated. Good long-term policy is good shortterm policy.

But I will note that in terms of eliminating the double taxation

on dividends, we live in a very competitive global economy now. If

we make the right decisions in our economy, our ability to attract

capital to the U.S. economy is much bigger than it was perhaps 20

years ago. In other words, with the economy the way it is today

around the world, the rewards of good policy are magnified more

than they were in the past and the punishment for bad policy is

magnified more than it was in the past. There is a reason why

France is suffering the economic stagnation they are suffering, why

Germany, why Japan, why countries like that are suffering, whereas other countries that are reforming their tax codes, reducing the

burden of government, why they are doing so well.

Let me talk a little bit about increasing economic growth. In my

full testimony, I cite a number of different papers by academics

looking at the economic growth impact. I look for the Heritage

Foundation. Allow me just to cite what our number-crunchers in

the Center for Data Analysis came up with, that the President’s

proposal would increase the employment level by an average of

more than 300,000 jobs a year, increase GDP by an average of $40

billion, increase business equipment new purchases by $32 billion

a year.

Also, very importantly, because you are getting additional economic growth from fixing the double taxation of dividends, you will

get revenue feedback. Our Heritage number-crunchers estimate

that the dynamic cost of the tax cut is only about one-third of the

static cost of the tax cut.

Let me go ahead and touch on the death tax real quickly. Again,

we see numbers, not only from all the academics, but again from

our people at Heritage, showing higher GDP, more jobs in our economy, increases in disposable income for workers.

On the issue of Social Security benefits, unfortunately, there isn’t

a lot of data out there. We made a search of the literature. It is

not something that has been pored over. But as an economist, I am

perfectly happy to stick with theory, and one important thing about

the double tax on Social Security benefits, you only pay that tax

if you have non-Social Security income that pushes you up into

that $25,000 range, and then, of course, the $34,000 and up for the

85 percent tax. So, in other words, it is only if a taxpayer, an elderly taxpayer, is providing labor and capital to the economy that that

taxpayer is going to get hit by this double tax of Social Security

benefits, and that, of course, means that there must be some adverse economic impact, although, again, I am sorry to say that we

don’t have a whole lot of research out there that allows us to put

our finger on that.

With that, I see that the red light is on. Why don’t I go ahead

and turn it back over to you, Mr. Chairman.

The CHAIRMAN. Thank you very much.

[The prepared statement of Mr. Mitchell follows:]

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The CHAIRMAN. Now, let us turn to Dr. Mark Crain, a Professor

of Economics at George Mason University. Doctor, welcome.

STATEMENT OF W. MARK CRAIN, DIRECTOR, CENTER FOR

STUDY OF PUBLIC CHOICE, AND PROFESSOR OF ECONOMICS, GEORGE MASON UNIVERSITY, FAIRFAX, VA

Mr. CRAIN. Thank you, Mr. Chairman and Senator Carper.

Thank you for inviting me.

I really want to highlight three effects of the double taxation of

dividends. The first is to highlight the economic distortions; second,

to highlight the potential for improving corporate governance if

dividends are excluded from taxation; and third, I would like to discuss some recently provided data from the Federal Reserve on the

Survey of Consumer Finances that, I think, really illustrates this

idea that older workers and seniors are likely to benefit disproportionately from the President’s proposal to exclude dividends from

taxation.

I do want to maybe restate this, because I do think it is so important in this debate and it seems to have been missed, it has been

emphasized but maybe hammering it home again is worth the effort here, and that is that the most important, I think, perspective

here is the effect on the economy and that economy growth research now almost universally recognizes the fundamental role of

well-functioning financial markets, and the reason is straightforward.

Financial markets provide the mechanism whereby national savings are channeled into new investments in plants and equipment.

The rate of investment determines the available capital stock per

worker and whether that is going to increase, decrease, or remain

the same, and the amount of capital per worker is the critical

determinant of how much the Nation produces, and how much the

Nation produces ultimately determines our standard of living.

The current system that taxes shareholders twice, once at the

corporate level and once at the shareholder level, is a bad policy,

and this policy of double taxation affects capital markets and thereby limits living standards in two ways. First, it is going to reduce

the rate of permanent investments that would be lower than they

would be without double taxation, and second, even for a given

amount of savings, double taxation distorts incentives in financial

markets to channel these funds into investment activities that

would produce the highest return, that is, those investment activities that would be most productive and generate the highest returns.

Now, on the first point, the elasticity of savings investment with

respect to the taxation rate, the empirical evidence is a little mixed

on that. I think if you have a cautious reading, we might say there

might not be a major response in terms of the total amount of investment. But on the second point, the impact of double taxation

on the efficiency of capital markets, the evidence and the theoretical analysis is compelling.

First, double taxation creates an incentive to invest in non-corporate rather than corporate businesses. Second, it creates an incentive to finance the corporate investments with debt rather than

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new equity. Third, corporations have distorted incentives to retain

earnings and thereby avoid the double tax.

There are some quite important empirical analyses of these effects and I think the results, again, are quite convincing, that the

effect of the reduction of dividend taxations would increase dividend payouts, would increase corporate spending on investments,

and reduce the firms’ cost of capital. In other words, reducing or

eliminating dividend taxation facilitates the incentive of corporations to raise equity capital as opposed to debt finance capital and

this gets channeled into the purchase of new plants and equipment.

The effect has been stressed here before that increasing, or reducing the tax would also increase dividend payouts, and this adds

liquidity to the capital market in the sense that earnings that were

otherwise retained within the firm are now going to be unlocked

and put back into the hands of shareholders to invest that capital

in other higher-return opportunities.

The effects on corporate governance have been stressed. Paying

dividends is an easy way to monitor corporate performance. It really reduces the cost of monitoring corporate governance and we

would expect there to be, with the lower cost, to be more of that

monitoring of corporate governance, and I think we would see

broad effects and improvements in corporate governance in the several ways that have been mentioned.

Finally, Mr. Chairman, and I won’t have time to go through all

these, maybe we can come to them in the questions, but I have provided three tables from the January data on the Survey of Consumer Finances which show a breakdown of the holdings of corporate equity, of stock by age group, and essentially, these data reflect this life cycle behavior of asset accumulation that Dr. Hubbard

talked about, over one’s lifetime, how you begin to accumulate assets and that by the time you hit retirement age, above 65, you

have accumulated a substantial amount of equity holdings.

In fact, in 2001, the latest data reveal that the median holding of equities was $150,000 for individuals 65 and older, which was

almost double the size of the next cohort group. So seniors are

heavily invested in the stock market, the latest data reveal, and I

think that these proposals to cut the dividend tax and to improve

capital markets will have a major impact on seniors who hold a lot

of this stock market wealth.

Thank you, Mr. Chairman.

The CHAIRMAN. Doctor, thank you.

[The prepared statement of Mr. Crain follows:]

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The CHAIRMAN. Thank you all very much. Dr. Mitchell, Dr.

Crain, I am going to ask some questions of both of you that I would

appreciate your responding to.

In Dr. Hubbard’s testimony, he said that the double taxation

elimination could, in the end—and I thought this was very fascinating, an aspect of it I did not understand—could reduce the

cost of capital anywhere from 10 to 25 percent. Do you agree with

that statement?

Mr. CRAIN. I agree in the sense that I believe he was talking

about the corporations, and I think that——

The CHAIRMAN. He was——

Mr. CRAIN [continuing]. That is the——

The CHAIRMAN. But he was also, therefore, as I understood it,

and you can follow me up on this, therefore talking about investment, therefore talking about corporate stability, therefore talking

about stock market stability, therefore talking about growth in the

economy.

Mr. CRAIN. Absolutely, and I think part of that is this distortion

caused by the tax, which causes funds to go into either debt-financed capital or investments in other types of activities, real estate, other types of investments rather than corporate investments,

and the idea here would be that those investments would be more

productive and, by reducing the tax, would attract capital to the

numbers he gave back into corporate investments.

The CHAIRMAN. Do you agree with that?

Mr. MITCHELL. I agree with Dr. Hubbard’s testimony. When individuals are looking whether to invest, they are making that decision based on what the after-tax income they expect to receive is,

compared to the amount of consumption that they are currently

willing to forego by setting that money aside and investing it. People invest in hopes of making a profit.

I forget, I think it was Senator Hatch who said, or Senator

Smith, ‘‘That if you tax something once, you are going to get less

of it.’’ If you double tax it, you are going to get doubly less of it.

When we are looking at whether corporations are able to attract

capital at reasonable cost, investors obviously are less willing to

provide capital when you have these two layers of tax imposed

upon that income, not to mention then you have to factor in that

a lot of these people are also going to be hit by the death tax and

other forms of taxation, as well.

The CHAIRMAN. While this question was not asked, and I am not

sure that in her testimony Ms. Kramer mentioned it, although we

were visiting about it earlier, the impact of the elimination of double taxation on that senior, let us say, using your chart, Dr. Crain,

who has got an investment at age 65 of about $150,000 worth of

assets or stock, and he or she or they are being taxed on it today,

not only would the tax elimination there obviously benefit them directly by less taxes paid, but Ms. Kramer makes the argument that

corporate America more than likely, with the enhancement of the

environment in which dividends are paid, would end up paying

more dividends or it would become more attractive for corporations

to do that and, therefore, would cause investors to seek out companies that paid higher dividends.

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Is there a scenario there in your mind where not only does the

senior benefit from not paying a tax in this doubly taxed environment, but could actually gain more dividend receipt?

Mr. CRAIN. Absolutely, in that it is—the analogy to static analysis was mentioned, in the sense it is hard to say exactly right now

how senior citizens would behave if dividends were not taxed, surely they would invest more in dividend-paying companies if the law

were changed. So you can’t really look at the data today to get a

handle on that because investment behavior would change if you

eliminated the double taxation. More seniors would invest in these

non-taxable dividends, as everyone would.

The CHAIRMAN. Part of my question, though, was would there be

a higher rate of dividend return on the current investment? Would

it change the corporate environment in that way?

Mr. CRAIN. By eliminating the tax, yes, you are going to encourage more dividend payments and it would raise the return.

The CHAIRMAN. Do you agree with that, Doctor?

Mr. MITCHELL. Yes, I do, and we also have some international

evidence to this effect. Many of the countries that are in the lower

range of the chart over there, that have much lower combined tax

rates on dividends, used to make the same mistake we made about

double taxing dividends, or at least of having less relief, and in my

full testimony, you will see that New Zealand and Australia are

two of the countries that eliminated double tax on dividends and

there is already some evidence, even though we are only talking 10,

15 years of data, there is already some evidence that it has had a

positive effect on both aggregate levels of investment in the economy and on dividend payment rates.

We also see that—as a matter of fact, President Clinton’s Treasury Secretary, Larry Summers, did a paper with another economist

looking at what has happened when the United Kingdom made reforms to their dividend taxation, and again, we saw positive responses.

Now, of course, it is always difficult to estimate ahead of time

the level of these responses, and I think Mr. Hubbard was being

very responsible in giving a range, as opposed to trying to pick an

exact number, but there is no question that his direction is the

right direction in terms of the numbers he is talking about.

The CHAIRMAN. Thank you.

Senator Carper, questions?

Senator CARPER. Thanks, Mr. Chairman.

Not so much a question, but to Mr. Buxton, I noted with interest

that you are an old Navy guy.

Mr. BUXTON. Yes, sir.

Senator CARPER. I was a Navy Midshipman at Ohio State, graduated in 1968. When you were on active duty, what were your assignments?

Mr. BUXTON. I had a variety of assignments, but primarily, I am

a qualified surface warfare officer.

Senator CARPER. What kind of ships did you serve on?

Mr. BUXTON. Destroyers, LPHs, the Valley Forge, Cone DD866.

Senator CARPER. I am a retired Captain, as well, so I feel a certain kinship with you. Your Governor out there is Dirk Kempthorne, who used to serve here in the Senate. I was Chairman of

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the National Governors Association when he first became Governor

in 1998 and attended New Governors School in Wilmington, DE. I

hope he is doing well. If you ever see him, tell him that an old Governor from Delaware sends his very best.

Mr. BUXTON. He is struggling with the tax issue, too.

Senator CARPER. I am sure he is. So are most of the Governors.

A lot of the States, as you know—— The CHAIRMAN. In fact, Tom, it is fascinating you make that comment. I think our Governor right now would find that it would be

easier being a U.S. Senator than a Governor, where you found it

very easy being a Governor during those great years of growth. Excuse me.

Senator CARPER. Absolutely, and most Governors would certainly

agree with that, and that is not to say our load here is not heavy

at times.

You are from Boise, right?

Mr. BUXTON. Yes.

Senator CARPER. Your mayor, I think, Mayor Coles, used to, I believe, be the head of the Mayors Conference—— Mr. BUXTON. Last year.

Senator CARPER [continuing]. He was a very good partner of a

number of us who were interested in passenger rail service. He was

a great champion of that. So we think well of you and your State

and it is a pleasure to serve with your Senators now.

I guess the question I have—is this the last panel, Mr. Chairman?

The CHAIRMAN. It is.

Senator CARPER. The first panel was the panel that included Dr.

Hubbard and Ms. Kramer, is that correct?

The CHAIRMAN. Yes.

Senator CARPER. I was just wondering, the five witnesses that we

had before us today seemed to be pretty much in tune with one another and their message is consistent in supporting what the administration has proposed. I am just wondering, did we invite anybody with a contrary opinion?

The CHAIRMAN. You had that opportunity, surely.

Senator CARPER. But we didn’t take it up? We will have to do

that, just to make things interesting.

The CHAIRMAN. All of these hearings are balanced off with minority and majority staff in the selecting of witnesses and those

kinds of things.

Senator CARPER. Next time, we will have to be sure that we suggest that. That is not to take anything away from the testimony

of each of these witnesses. They are stimulating and provocative

and interesting.

I just want to conclude by saying thank you. I have no questions,

but I want to thank each of you for coming and for sharing your

thoughts with us, and a special welcome to my Navy buddy over

there, Captain Buxton. Thank you for joining us.

The CHAIRMAN. Tom, rest assured, I would be very happy to

allow the record to show that the support of the President’s proposal for eliminating double taxation on dividends is not unanimously supported, either in the Congress or the country, but I

think it has us all scratching our heads at this moment and I think

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what our intent of this hearing was, not only the double taxation

of seniors, but the increased double taxation of seniors in a variety

of income levels that they have, and, of course, because they are

fixed-income people, that there is substantial impact.

What attracted me to this was when the President was proposing

his package. He called it relief for seniors, and at the time, it had

not really focused—I had not focused on the fact that we now have

the figures that over 52 percent of the tax benefit would go to seniors, and we see that there is a broad cross-section out there that

now hold investments—you can’t call them wealthy if their whole

life savings is tied up in a retirement program and $150,000 worth

of assets in stocks. That is their life savings, if you will, and the

impact that it is having on that.

Dick, would your investment, or do you think your parents’ investment would be different if they had recognized early on that

dividends would not be double taxed?

Mr. BUXTON. No. I think that they invested, and their investment is primarily in energy stocks, utilities, was for a return on investment with dividends.

The CHAIRMAN. But they were looking at it for purpose of dividend return, not speculation on stock values as much?

Mr. BUXTON. No. That is correct. No. Idaho Power pays a dividend of almost 6 or 7 percent, as you are probably well aware.

The CHAIRMAN. Yes.

Mr. BUXTON. They are highly invested in Idaho Power and they

did it for that reason.

The CHAIRMAN. So for your family, owning stock that returned

dividends was critical to their investment plan or strategy?

Mr. BUXTON. Even my own, I tried to invest in that. Of course,

a lot of my stock is now in my IRA——

The CHAIRMAN. Sure.

Mr. BUXTON.—which I still do that because I think that they are

more responsible if they are paying a dividend.

The CHAIRMAN. Thank you.

Dr. Crain, your testimony discusses the potential for increasing

returns for all investors if we end the double taxation of dividends,

including those who have stock holdings in tax-deferred accounts.

Could you elaborate on how these increased returns might occur?

Mr. CRAIN. Yes, Senator. Broadly, through this improved efficiency of capital markets, for example, this change in the reliance

on equity financing as opposed to debt financing that has been

mentioned a couple of times today. Through the dividends, again,

make it easier to monitor corporate performance and corporate governance, which I think is a major factor here that is going to increase and improve the returns, even in stocks that are held outside of—in a tax-deferred account.

The CHAIRMAN. Does that mean this proposal will be a positive

force for returns of defined benefit pension plans with company

stock, including State pension plans and union pension plans?

Mr. CRAIN. Absolutely, Senator. I chair the Corporate Governance Committee——

The CHAIRMAN. That is where I was headed. Does this change

the character of the thinking of that organization?

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Mr. CRAIN.—for the Virginia Retirement System, and sometimes,

it is overlooked of how hard it is to really get information about

what is going on inside a company. Even a large organization like

the Virginia Retirement System, a $29 billion plan, it is almost

prohibitively expensive for us. We must hold stocks in 3,000 companies. How do you monitor all those? It is extremely costly to do

that. This would reduce that cost, not only for us, but for all other

plans in that we would see benefits, benefits in terms of improved

performance of companies.

Senator Carper was asking, I thought, a very good question

about what is the tradeoff with the effect on States and their borrowing costs and so. But I do think, and this wasn’t mentioned by

Dr. Hubbard, is that States have an enormous liability to their

pension plans. The States are going to have to pay that if the returns don’t come in to fund those plans. The taxpayers will ultimately be liable to pay those benefits, and here is a way to help

fund, fully fund the plans and, I think, reduce the liability on future taxpayers in the States.

The CHAIRMAN. Thank you very much.

Let me turn to our colleague who has just joined us from the

State of Missouri, Senator Talent. Welcome.

STATEMENT OF SENATOR JAMES M. TALENT

Senator TALENT. Thank you, Mr. Chairman. My apologies for

being late. I did want to attend this hearing and I want to congratulate you and Senator Breaux on the direction you are taking

the committee. I really sought, as you know, to be on this committee, because I think a lot of the issues that we are going to be exploring are just second to none in terms of importance to America

as a whole, as well as the nation’s seniors.

The thing I am concerned about is what is going to happen to

people who are now at or entering middle age and have, to this

point, planned their lives on certain assumptions about the position

seniors have been in in the past, assumptions which I think are

generally not going to be true at the time that they are retiring,

and we had a hearing which I think Senator Breaux originally

scheduled on Social Security.

One of the answers, and I think we are going to have to package

a lot of answers to that, but one part of the answer is to really publicize to people the need to prepare themselves more for retirement

than they had thought they might have to and then empower them

to do it. I see the subject of this hearing as an avenue of accomplishing that.

Now, let me just ask you, and I don’t know, if this has come up,

I apologize and maybe just deal with it and dispose of it briefly,

but the taxation of Social Security benefits, which I hear about all

the time back home. Seniors really don’t like it. Have any of you

commented on a feature of it that I think is particularly unfair, because payroll taxes are supposed to go to Social Security and Medicare, and except for the surplus that we spend on other things,

they do. But when you tax the Social Security benefits, isn’t that

just a way, really, of converting the payroll tax into a general tax?

I mean, you collect the payroll tax, you pay the Social Security

benefits, you tax the Social Security benefits, and then that money

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comes into the general revenue. Seniors back home have figured

this out. Am I wrong in saying that? Isn’t that the effect of taxing

Social Security benefits?

The CHAIRMAN. Gentlemen?

Mr. MITCHELL. Under current law, Social Security payroll taxes

are 50 percent deductible, the so-called employer half of it. If you

want a neutral tax system, in other words, if you want to treat Social Security the way you would treat savings under a neutral tax

code, then the benefits should be 50 percent taxable.

So it is very clear that the tax increase on benefits that was enacted in 1993 does represent double taxation of those benefits, and

as was discussed a little bit earlier, that will have some adverse

consequences on the economy because people only pay that double

tax if they have non-Social Security income by either providing

labor or capital to the marketplace. So it is double taxation and it

is double taxation that, like other forms of double taxation, undermines the economy’s performance.

Senator TALENT. And pulls the money, Mr. Chairman, out of, if

you will, the use for which it was originally intended. I mean, it

is not like the money that we collect through that tax we then turn

around and use for other kinds of senior programs necessarily. It

goes in the general fund with everything else. So the effect of it is

to take the payroll tax and use it for other kinds of measures.

I thank the Chairman for hosting this. Again, I am sorry for

being late. I intend to look through your statements. This is an important subject, and I know we are planning to do hearings on a

number of other subjects, Mr. Chairman, to examine where we

need to be 15 or 20 years from now in order to have a viable and

high-quality system that cares and meets the needs of the seniors

of the next generation, and I thank you, Mr. Chairman.

The CHAIRMAN. I thank you very much. I think the hearing that

Senator Breaux chaired a couple of weeks ago as we looked at the

overall view of Social Security and we had General Accounting up,

I mean, it was obvious to us then, and I think we all agreed, that

the ‘‘do nothing’’ strategy just does not work, and at some point in

the very near future, hopefully, we wrestle through the tough

choices there.

Senator TALENT. Mr. Chairman, will you yield on that point?

The CHAIRMAN. I would be happy to.

Senator TALENT. I mean, one other area, for example, I am very

interested in, and you and I have talked about this privately, is

what the spectrum of services and care of a long-term nature needs

to be for seniors 10, 15, 20 years from now, you know, everything

from assisted living to independent living centers to long-term care,

and how do we get people from here to there. Part of that is going

to be empowering people and urging them to save on their own for

those kinds of alternatives.

So I see all this as a seamless web, as we lawyers say periodically, and each one of these hearings has part of the kind of decisions we are going to have to confront soon if we are going to be

effective in helping the nation’s seniors.

Thank you. You have been very patient, Mr. Chairman.

The CHAIRMAN. I thank you and I think your point is very real,

even though when we talk of Social Security and today talking

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about double taxation of dividends, what is obvious is that there is

a very real impact on today’s wage earners. Even though they may

not be the subject of the tax or the person who is the immediate

recipient of the program, it does impact, and you have all said that,

wages, job opportunity, the general economy itself, and that is all

an important part of it.

Of course, the thing that I have grown increasingly concerned

about—it is part of the reason I am on this committee—the beautiful thing that is going on out there right now, I just penned a

note this morning to a neighbor of mine who celebrated his 90th

birthday at the Weiser, Idaho, Senior Citizen Center on Sunday.

He walked in under his own power. He drove his own car with his

wife. He is having a great time in life. His problem is, and it is

a beautiful problem, he had eight children, and if he has got those

kinds of genes, he has probably produced eight children that are

going to live to be 90-plus and they are going to drain Social Security. [Laughter.]

Unless we reform it to respond to the demographics, Senator Talent, that you have spoken to and the very reality of the community

that we are dealing with here.

Thank you all very much to our panelists. Thank you very much

for being here. Dick, thank you for coming from Boise.

The committee will stand adjourned.

[Whereupon, at 11:59 a.m., the committee was adjourned.]

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